China Researcher Carson Block Captures Investors’ Interest

The rise to prominence of Carson Block—an author, lawyer, and entrepreneur who has reinvented himself as a corporate fraud-buster—highlights the dearth of information among investors about Chinese companies listed on U.S. and other Western exchanges.

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Carson Block

Last week Mr. Block’s research firm, a tiny operation called Muddy Waters LLC, posted on its web site a scathing report about Sino-Forest Corp., a Chinese tree plantation operator listed in Toronto whose investors include hedge-fund titan John Paulson.

Muddy Waters alleged overstated profits and other malfeasance. Sino-Forest’s stock promptly tanked, despite the company’s strong denials. It is still trading now at about a third its level before the report was published.

It was the latest of five such reports Muddy Waters has published about small Chinese companies listed in the U.S., all with similar impact.

Muddy Waters gives no fixed address on its website and Mr. Block divides his time between Hong Kong and North America. He used to live in Shanghai but left following threats to his safety relating to his research, he says.

The quality of public disclosure by small Chinese companies listed in the U.S. has become a major concern for investors and regulators, a concern fueled by short sellers like Muddy Waters who bet on a stock’s decline.

Other short sellers also sometimes publish their opinions about listed Chinese companies. Mr. Block has an element of what he portrays as on-the-ground sleuthing in his investigations into how companies’ business operations compare with their public statements. That has helped him capture the attention of investors in the West who have little way of verifying for themselves the quality of companies operating on the other side of world in a country that speaks another language.

Equally, given the paucity of public data in China and a business culture where companies are typically reluctant to publicly disclose company information, it is difficult to verify Muddy Waters’s claims.

The 35-year-old Mr. Block boasts degrees in law and business and experience working for his father’s securities research firm. But he only recently came to the business of researching Chinese stocks, making his big impact in recent months all the more remarkable.

Mr. Block declined to be interviewed this week. But in two earlier interviews and a series of email exchanges this week, he said he was born in New Jersey and grew up in California. He earned a business degree in from the University of Southern California Marshall School of Business, then a law degree at Chicago-Kent College of Law.

According to information on the Muddy Waters website, he worked for CIBC World Markets Inc., the wholesale banking arm of Canadian Imperial Bank of Commerce, for a stint until mid-1999, then when he went to work for the Los Angeles-based equity research company his father had set up: W.A.B. Capital LLC. He left W.A.B. Capital in mid-2001, but has done occasional projects for it since.

Mr. Block moved to Asia in September 2005, and worked for about 15 months in the Shanghai office of U.S. law firm Jones Day. His book “Doing Business in China for Dummies” was published by Wiley & Sons Inc. in 2007. That year, at the suggestion of an uncle back in California, he set up a self-storage business in Shanghai called Love Box Self Storage, an experience he describes on the Muddy Waters website as being “down in the trenches” of doing business in China. Love Box continues to exist. In 2008 he began teaching a series of legal classes in Shanghai for his old law school to Chinese students hoping to study in the U.S.

Speaking to the Journal in his unheated office during Shanghai’s freezing winter in January last year, Mr. Block expressed frustration at dealing with China’s bureaucracy and the difficulties of selling potential customers on the merits of paying for storage.

According to the Muddy Waters website, Mr. Block’s route to short-selling overseas-listed Chinese companies came via his father, who got interested in Chinese small caps late in 2009. W.A.B. Capital, owned by his father, writes research reports about small companies which W.A.B. Capital then distributes to a network of institutional investors. W.A.B. Capital gets paid in stocks and warrants in the companies it researches, which the firm says aligns its interests with any investors who purchase stakes in the companies as a result of its research, according to its website.

At his father’s request, Mr. Block says he started in 2009 doing research on Orient Paper Inc., a paper manufacturer and distributor based in Hebei province and listed on NYSE Euronext’s American Stock Exchange. Mr. Block says the original plan was to offer W.A.B. Capital’s standard research services to Orient Paper if the company had promise. According to Mr. Block, it didn’t, and neither he nor W.A.B. Capital ever made the offer to Orient Paper.

W.A.B. Capital never issued a report. But in June 2010, Orient Paper became the subject of Muddy Waters’s first report. Published on the firm’s website, the report alleged that Orient Paper had overstated its 2009 revenue by about 40 times, and that it overvalued its assets by at least ten times.

The report claimed that Orient Paper had paid much less for plant and equipment purchases than it claimed, that its top 10 customers in 2009 were too small to buy the volume of stock Orient Paper claimed, and that activity at the Orient Paper factory Mr. Block visited fell far short of what was necessary to meet the company’s claimed output.

“We are confident that [Orient Paper] is a fraud. Its purpose is to raise and misappropriate tens of millions of dollars,” said the report, which noted on its front page that Muddy Waters had shorted the stock.

That conclusion was not based on an analysis of Orient Paper’s books, but by talking to its customers, contacting suppliers of assets comparable to what Orient Paper said it had bought, having “experts” analyze photos of the company’s production equipment, and drawing conclusions from a visit to the Orient Paper factory in January 2010, the Muddy Waters report said.

Within two days, Orient Paper issued a press release saying the report contained “inaccuracies, omissions, fabrications, and unsubstantiated claims.” It said that Mr. Block had offered to write a paid research report on the company.

Orient Paper commissioned an independent investigation into the allegations, led by its audit committee. The resulting report, issued in November 2010, found “no evidence to support the allegations made by Muddy Waters that Orient Paper misappropriated funds from investors, no evidence that we overstated our revenues, no evidence that we overstated the number of workers we employed and no evidence that our disclosures regarding our top 10 customers support charges of fraud,” according to an Orient Paper statement at the time.

Orient Paper also said that when Mr. Block visited it in January 2010 he offered to publish a positive research report on the company “in exchange for a large sum of money and equity compensation.”

Mr. Block, in a report posted last July on the Muddy Waters web site, said neither he nor W.A.B. Capital ever made any offer to provide paid research services as it never got past the due diligence process on the company.

A spokeswoman from Orient Paper said Thursday that the company’s business wasn’t hurt long-term by the Muddy Waters report. But she said its stock price is still suffering.

“We have confidence that by maintaining best practice and good operations, the market will soon recognize the company’s value,” she said. She said Orient Paper has had no formal contact with Muddy Waters since the report was issued.

Orient’s shares traded recently at $3.52, down from above $8 where it was trading before Muddy Waters issued its report.

Bill Block, Carson Block’s father, said in an interview he is proud of his son’s accomplishments, and believes his son is protecting investors even as his personal profile has grown. “Let’s put it this way,” Mr. Block said of his son. “He’s risen above obscurity.”

Since the Orient Paper report, Muddy Waters has issued reports on four other companies, including Sino-Forest Corp., all of which it has accused of exaggerating the true extent of their businesses. Muddy Waters doesn’t disclose the size of its positions or how much it makes on its investments.

Bloomberg News

Billionaire hedge fund investor John Paulson is among stockholders in Sino-Forest, a company targeted by short seller Carson Block

In a statement issued Monday, Sino-Forest said it “believes Muddy Waters’ report to be inaccurate, spurious and defamatory.”

It said it has set up an independent committee to address the allegations, and hired PricewaterhouseCoopers to assist with the investigation.

On Wednesday, Sino-Forest said the Ontario Securities Commission had opened an investigation, prompted by unusual trading activity in its stock and the Muddy Waters’ allegations. Sino-Forest said it welcomed the investigation.

In response to reports by Muddy Waters and two other short sellers about China MediaExpress Holdings Inc., its chief executive in February issued a statement “categorically” denying what he called “reckless and baseless attacks.” A spokesman for MediaExpress told The Wall Street Journal an independent investigation currently underway at the company would prove that key accusations by Muddy Waters are wrong.

RINO International Corp. declined to comment for this story. A week after Muddy Waters issued its report on RINO in November 2010, RINO’s CEO acknowledged to the board and the firm’s auditor that RINO “did not in fact enter into two of the six” customer contracts that Muddy Waters claimed were fabricated, according to a RINO statement filed to the SEC. “There might be problems” with 20% to 40% of the company’s other contracts, the statement said, citing the CEO’s comments.

Mr. Block said Muddy Waters isn’t exclusively about selling stocks short. “There are good Chinese companies listed in the U.S. We intend to identify and recommend Strong Buys on them,” he said on the company’s website. As yet Muddy Waters hasn’t issued any buy recommendations.

Comments (5 of 13)

This article and the comments are finally pointed out the obvious. When do the Security Commissions wake up?

1:52 pm July 26, 2011

Joseph wrote :

Are people aware that Carson Block worked as a paralegal at Jones Day in Shanghai and not as a lawyer? See the article by the Financial Times.

So now we have a paralegal giving equity advice?

I think many in the media have been punked!

9:08 pm July 1, 2011

JusticeNeeded wrote :

We have to admit that Carson Block is doing all his DD for his very own profit.

If as he said he was doing this for protecting investor, why he put an attacking letter to SPRD at open hours, which caused a mad panic and many stop-losses were triggered. Now he backed off saying he may misunderstand the reports and at least he was trying to improve the transparent of the company to public. If he is a decent man, truly thinking for investors, he should just post his letter in a close-trading hour and give investors time to digest and give the company time to refute.

Someone said he had a perfect track to bring down fraud companies. It is absolutely NOT true. ONP is an example which he failed to give proof and just moved on with his shorting profits. SPRD is just another example. Note that he has still not given solid proof for his fraud allegation regarding to Sino-Forest Corp.

But irrelevant of whether his allegation was wrong or right, he always won with huge chunk of profit. There is no punishment and justice for his behavior!!!

2:31 pm June 29, 2011

Michael wrote :

This is a systems problem of more than individual companies alone can fix.

Right now regulatory laws are safeguarding against insider trading – using good information in an unfair manner. But this is a problem at the other side of the spectrum.

He can be right. He can be wrong. He always gets paid.

In fact, he can look right when he is wrong. When scams win, people may simply give up on a sinking boat. It is not the job of businesses to do regulatory work, whether it is in Greater China or in North America.

This debacle is now leaving a trial of carnage not just with investors in the US but also in Canada, with pension funds and the press suing and being sued.

As I read more about Muddy, he seems to be working backwards to get to his goal in his reports.

You can’t be that incompetent if you have a business degree and a law degree – unless the lack of due diligence and gross disregard of the truth would pay.

He has his own agenda and his reports proves his own agenda.

But even with the regulatory loop hole, due diligence and gross disregard of the truth at his caliber is still a problem for him.

2:30 pm June 29, 2011

Michael wrote :

As I read more about Muddy, he seems to be working backwards.

You can’t be that incompetent if you have a business degree and a law degree.

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